Axalta Coating Systems Ltd. (NYSE:AXTA) Q4 2022 Earnings Call Transcript

Axalta Coating Systems Ltd. (NYSE:AXTA) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Hello, and welcome to the Axalta Coating Systems’ Fourth Quarter and Full-Year 2022 Earnings Conference Call. As a reminder, this conference is being recorded. It’s now my pleasure to turn the call over to Chris Evans, Vice President, Investor Relations. Please go ahead, Chris.

Chris Evans: Thank you, and good morning. This is Chris Evans, VP of Investor Relations. We appreciate your continued interest in Axalta and welcome you to our fourth quarter and full-year 2022 financial results conference call. Joining me today is Rakesh Sachdev, Non-Executive Board Chair; Chris Villavarayan, CEO and President; and Sean Lannon, CFO. Yesterday afternoon, we released our quarterly and full-year financial results, and posted a slide presentation along with commentary to the Investor Relations section of our Web site at axalta.com, which we will be referencing during this call. Our prepared remarks, the slide presentation, and our discussion today may contain forward-looking statements, reflecting the company’s current view of future events and their potential effect on Axalta’s operating and financial performance.

These statements involve uncertainties and risks, and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. Our remarks, the slide presentation, and our discussion may also contain various non-GAAP financial measures. In the Appendix to the slide presentation, we’ve included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. I will now turn the call over to Rakesh.

Rakesh Sachdev: Thank you, Chris. And welcome, everyone, to our fourth quarter and full-year 2022 earnings call. Let me begin by expressing my appreciation to the team for delivering another strong quarter. The company showed substantial improvement in profitability, most notably in our Mobility Coatings segment, and achieved earnings near the top of our fourth quarter guidance range, setting us on a positive trajectory into 2023. Before the management team outlines the details of our quarterly results, I want to introduce and welcome Axalta’s new CEO and President, Chris Villavarayan. Chris joined us on January 1, where he recently wrapped up his tenure at Meritor, a global industry leader of commercial vehicle drive trains and engineered systems.

Christ spent the past 22 years supporting and ultimately playing a leading role in the remarkable transformation of the company, which delivered above-market growth, margin expansion, and substantial shareholder value creation. Chris is a seasoned global executive who has distinguished himself as a strong leader. His decades of commercial and operational experiences align well with the skill sets that the Board believes are necessary to achieve Axalta’s long-term strategic ambitions. The Board has a high degree of confidence that, under Chris’ direction, Axalta will be better positioned to unlock value for all stakeholders. As for myself, I’ve transitioned to the role of Board Chair with Chris’ appointment as the CEO. It has been a fantastic few months serving at the Interim CEO, getting deeper into our businesses, helping the team focus on the immediate value levers, and doing the initial planning for our 2023 objectives.

The valuable insights I have gained over the past five months will clearly help as I lead the Board and support Chris to unlock the full potential of this company. I will now pass the call over to Chris. Chris?

Chris Villavarayan: Thank you, Rakesh, and good morning, everyone. I want to start by saying it is a true privilege, and I’m absolutely honored to become the CEO and President of Axalta. My first few weeks in the role have only strengthened my belief that Axalta is a true industry leader with immense opportunities ahead. In the coming weeks and months, I look forward to meeting many of you, our employees, customers, and investors, as we accelerate our growth plans. This is an important moment for Axalta. I’m committed to delivering superior financial returns and ensuring we meet our customers’ demands. Now on to our quarterly results, with highlights on slide four. The fourth quarter was strong and the team has a lot to be proud of.

We delivered adjusted EBIT of $147 million, and adjusted diluted EPS of $0.38, both at or slightly above the top end of our fourth quarter guidance range. This was driven by pricing momentum and volume growth, with notable margin and profit recovery from Mobility Coatings. Constant currency net sales growth, of 14%, was very strong, driven by double-digit pricing growth across all our four end markets, and modest volume contribution. Volume growth, of 2%, was led by market recovery in both light and commercial vehicle. Our slate of award-winning new products and customer-centric service models are driving new wins across the portfolio. Meanwhile, post-COVID normalization in our end markets creates a unique opportunity for us to grow volume and outpace broader industry trends.

We again delivered strong year-over-year price mix growth of approximately 12% in Q4. Price mix improved 3% sequentially, the highest realized quarter-over-quarter improvement since 2020. This is a fantastic outcome that reflects strong execution of the new actions, and highlights our prioritization of margin recovery. Pricing in the period offset substantial year-over-year variable cost inflation again this quarter, but raws remain well above historical levels. We continue to face pockets of cost pressure from inflation in labor, energy, and select specialty raws that require us to maintain our pricing momentum and prioritize better execution. I will cover this in more detail in the following slide, and highlight where I intend to focus over the coming months.

Axalta’s strategic priorities remain unchanged for the foreseeable future. We will strengthen our core and drive growth, while increasing our emphasis on improved near-term execution and margin recovery. This will continue along the trajectory which Rakesh was aggressively driving in the back-half of 2022. By focusing on a few key areas, we can better control our destiny, strengthen our balance sheet, and add a tremendous amount of value regardless of the external environment. First and of utmost importance is margin recovery. The teams are doing a great job here, and this quarter’s results reflect our heightened focus on pricing. This is especially important as we face areas of inflation in labor and energy costs, coupled with the carryover impacts of raws and freight costs that accelerated throughout 2022 before stabilizing in the fourth quarter.

Next to cost productivity, we have over $1.5 billion in fixed costs and another $2.5 billion in variable costs, including raw materials, freight, and energy. Given the large scale of spend and more than 46% of increases in variable costs over the past two years, we anticipate that we will drive cost enhancements to add considerable value to the bottom line. Another area of emphasis will be operational and supply chain excellence. I have spent most of my career in this area, ensuring safe and efficient operations for a global company. At Axalta, I see opportunity to increase capacity, deliver more reliable production, and ultimately drive near-term manufacturing efficiencies. Lastly, we’re focused on driving better cash conversion, and ultimately bringing down the net leverage in this high-interest environment.

This is important following a year like 2022, where working capital has been greater than at $200 million use of cash. Altogether, these near-term priorities reflect our intent to better control the controllable and yield maximum profitability in any economic environment. Let’s go back to the results on slide six. I will now give you more color on our fourth quarter volume performance. Globally, volume improved 2% year-over-year driven by market recovery in Mobility Coatings and share gains across the portfolio. This is a strong result, and really speaks to Axalta’s unique market positioning and resilient end markets. Volume was up in all regions except Europe which declined by low single-digit year-over-year, and was mostly driven by the mid-teen percent decline in Industrial.

This was due to macroeconomic softening and the Russia-Ukraine conflict on the broader Performance Coatings segment. Macro conditions in China had mixed impacts on volumes. Auto production was again a bright spot, and Industrial benefited from significant sequential improvement as the economy reopened from lockdown periods, earlier in 2022. However, reopening and the subsequent spike in COVID cases did have an impact on traffic congestion and refinish activity. We see this as only a modest and temporary setback. Demand was very robust in Mobility Coatings, with volume improving 19% year-over-year, with positive contribution from every region. Global light vehicle and commercial vehicle production recovered from heavily constrained level in the prior year.

Moving to slide seven, I will now cover the Refinish business. It was great to join many of you at our investor event in December where we highlighted the long-term attractiveness of this resilient and growing business. At the event, we also focused on our unique value proposition built around the industry’s most productive waterborne paint system and our customer-centric service model. This enables us to partner with the fastest growing customers yielding market outperformance for our business and a consistent track record of strong financial returns. 2022 was another record profit year for refinish with strong volumes outpacing industry growth and successful execution of pricing action to offset inflation. Yet, there continues to be tremendous opportunity to continue our growth momentum that I will now highlight.

Industry volumes remained below 2019 level that we believe will normalize over time alongside return-to-work trend. Secular trends such growing car park, increasing miles driven, and distracted driving all together support increasing industry activity for the foreseeable future. Body shop consolidation is expected to continue and is still in the early stages serving to expand the size of the premium market segment where we have a strong selling position. Lastly, our refinish team is doing a great job indentifying adjacencies, many leveraging our recent U-POL acquisition to grow our addressable market within the auto repair and related consumer DIY markets. Let’s go to slide eight, where we will now review the Industrial business. The industrial end markets continue to soften from the combination of unprecedented inflation and more recently lower demand.

However, pricing remains a bright spot as industrial achieved double digit pricing gain every quarter this year and successfully offset year-over-year inflation beginning in Q2. On volumes, industrial continues to face pressure from weakening economic activity in EMEA as well as slower than expected recovery in China. More recently, higher interest rates have a negative on our construction end markets notably in North America. This has softened demand even further specifically in our coil and architectural extrusion business. However, our North American wood business remained strong with an order backlog extending into the first-half of 2023. Our EV business continues to grow with new offerings in battery components. Recently announced infrastructure and energy investment is expected to drive upside in the future of our industrial business.

Moving to Mobility Coatings on slide nine, the team delivered encouraging progress towards margin recovery in the quarter. I want to recognize the efforts of the team to deliver our margin recovery goals in Q4. Yet, we still have a way to go here before achieving the levels of profitability we want, particularly given the substantial value we provide to our customers. Margin recovery continues to be our highest priority. More broadly, we view current industry forecast to be favorable following several years of constrained auto production and depleted channel inventory level. We also expect to outpace industry growth rates into 2024 from a solid book of new business wins that we have built over the past 18 months. The new contracts are at an attractive contribution margin consistent with our historical levels.

We expect to accelerate the earnings recovery in the segment as new business launches throughout the coming year. Altogether, we have an increasingly better line of sight to an expected margin recovery that should be driven by industry growth, new wins, and margin improvement. Now let’s move to slide 10, and I will discuss the drivers of our margin performance. Between 2021 and 2022, the inflationary impact from the variable cost was unprecedented, inflating by 46% and totaling an approximate $640 million impact to EBIT. In response, we have achieved historic pricing realization and successfully offset the inflation year-over-year impact as of yearend. Yet, as a cumulated two-year gap remains for Axalta with negative contributions from three of the four end market which continues to depress our profitability.

We are fully committed to offsetting the cumulative impact of raw material, energy cost, and logistics inflation in all of our businesses. We showed good momentum in the fourth quarter as pricing more than covered the year-over-year impact from higher raw materials and logistic costs across all our four end-markets for the first time. The two-year cumulative price cost gap was cut in half from Q3 to Q4, and we were very pleased to see the positive shift in Mobility Coatings price costs during Q4. This supported a noteworthy improvement in segment margins. In the quarter, we also benefited from modest sequential cost relief in some upstream commodity categories driven by slowdowns in adjacent markets and better overall supply availability. Looking ahead, we see an opportunity for modest lower sequential unit rates to continue into 2023.

However, we’re cautious on the actual impacts in the first quarter, given that our inventory levels remain historically high. Inflation remains persistent in specialties like non-TiO2 pigments, energy and labor, where we do not see yet a path to relief. It is necessary for us to remain focused on price and cost actions to offset ongoing inflation and to fully recover the remaining cumulative price cost gaps. Now, I will turn the call over to Sean to discuss our financial results beginning on slide 11.

Sean Lannon: Thanks, Chris, and good morning, everyone. Net sales were $1.2 billion, an increase of 9% year-over-year for the fourth quarter while constant currency net sales increased 14% driven by pricing actions and strong market recovery in Mobility. Constant currency net sales growth included an 8% increase in Performance Coatings and an impressive 30% increase in Mobility Coatings as both light vehicle and commercial vehicle showed strong year-over-year performance. Fourth quarter volume improved 2% year-over-year as market recovery in Mobility more than offset the softer industrial environment and slower than expected recovery in China from COVID-19 lockdowns within Performance Coatings. Demand remains robust in Mobility Coatings where volumes grew 19% year-over-year due to pent-up demand and new business wins.

Price mix increased 12% year-over-year and 3% sequentially, which is reflective of this being our key priority across every end market. FX translation was a headwind of 5% on net sales for the fourth quarter, driven by a weaker Euro and Chinese Renminbi. During the quarter, we’ve recorded a $15 million charge as part of a new cost savings initiative being implemented in early 2023. We also incurred $15 million of costs associated with the term loan refinancing, executed in December. The $30 million combined impacts of these two items are excluded from adjusted earnings. Fourth quarter adjusted EBIT was $147 million, 22% higher versus the $121 million reported in the prior-year. Axalta’s adjusted EBIT margins increased by approximately 130 basis points year-over-year to 12%.

This is the first increase since the current inflationary period began in early 2021 with improvement in profitability in Mobility Coatings and Performance Coatings. This is an important milestone towards our margin recovery goal. Q4 performance also included an approximate $17 million EBIT headwind associated with the impacts from the Rush-Ukraine conflict, China COVID-19 challenges and FX translation. Turning to slide 12, Performance Coatings Q4 net sales increased 2% year-over-year and 8% ex-FX driven by a 12% price mix benefit, volumes for the segment were slightly lower as refinish share gains were offset by Russ-Ukraine impacts and headwinds from a slower than expected recovery in China. Industrial volumes were lower, mostly driven by a softer EMEA and North America.

Performance Coatings reported Q4 adjusted EBIT of $107 million versus a $100 million in Q4 of 2021 as a favorable year-over-year refinish contribution was partly offset by lower industrial profitability. Industrial made progress towards offsetting its cumulative price cost deficit this quarter, but this was more than offset by softer volumes. Segment adjusted EBIT margins improved by 60 basis points year-over-year to 13% in the quarter. Moving to slide 13, Mobility Coatings constant currency net sales increased 30% in the fourth quarter as volumes increased by 19%, which outpaced market build rates across light vehicle and commercial vehicle. A highlight of the quarter for Mobility was price mix growth of 12%. The team executed extremely well and remains focused on pricing discipline into 2023.

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Approximately $5 million of our price growth was driven by the recognition of retroactive price adjustments with several customers where the team had been in active negotiation since earlier this year. The two-year cumulative price cost gap remains a priority for Mobility, but we are encouraged by the progress to end the year. Mobility Coatings reported Q4 adjusted EBIT of $18 million versus negative $4 million in the prior-year quarter as volume and price mix growth were partially offset by raw material inflation, higher fixed costs, and the negative impacts of foreign currency translation. The sequential increase to adjusted EBIT was also noteworthy increasing from $4 million in the third quarter to $18 million in the fourth quarter, driven mostly by an inflection in the price cost environment as pricing increased by mid-single-digit percent and variable costs were largely stable throughout the quarter.

Segment adjusted EBIT margins improved by 530 basis points year-over-year to 4.2% in the quarter. Moving the slide 14 for a few comments on the full-year 2022 results, 2022 proved to be a challenging year as a series of exogenous headwinds impacted the business such as unprecedented variable costs, energy and labor inflation, constrained auto production, Russia, Ukraine dynamics, and COVID lockdowns in China. These headwinds together drove adjusted EBIT 9% below 2021 levels, though we’re ending 2022 on a positive trajectory, adjusted EBIT improved by 11% in second-half year-over-year, and 22% year-over-year in the fourth quarter, price mix increased 10% year-over-year in 2022 with a low single-digit percent sequential improvement every quarter.

That peaked in Q4 at 3% and despite the macro and geopolitical headwinds from Russia and China, full-year volumes increased 4% led by a strong recovery in light and commercial vehicle production, and was supported by new customer wins in every end market, including notable MSO wins in refinish and a record number of new light vehicle customer wins. We also ended the year having improved our balance sheet, which I’ll review in more detail in the following slide. Axalta’s fourth quarter balance sheet liquidity profile remained solid. We ended the year with nearly $1.2 billion in total liquidity. Our net leverage ratio is now at 3.8 times, reflecting a significant improvement for 4.1 times at September 30th. This reflects our commitment to focusing on free cash flow in the fourth quarter to address leverage.

With that said, net leverage remains elevated in part due to higher working capital balances associated with pricing and volume growth impacting accounts receivable as well as higher levels of inventory. Inventory build has been a use of more than $300 million over the last two years. Working capital balances at year-end were 11% of 2022’s full-year sales, which is roughly 300 basis points above our historical levels, which will now provide a nice opportunity into 2023. On capital allocation, we paid down $47 million of gross debt in Q4 and made no additional share repurchases in the quarter. Thus, the annual total share repurchases remained unchanged at $200 million. In December, we also successfully refinanced our $2 billion term loan, which resulted in the extension of the June 2024 maturity date to December of 2029.

On slide 16, we will review our Q1 guidance framework and 2023 outlook commentary. For Q1, we expect net sales growth between approximately 5% and 9% year-over-year inclusive of a 2% to 3% FX headwinds. We expect to generate adjusted EBIT of $126 million to $146 million, which we expect to correlate to adjusted EBITDA of $185 to $205 million, representing 8% year-over-year growth at the adjusted EBITDA midpoint. We expect this growth inclusive of headwinds associated with FX and the Russia-Ukraine conflict of approximately $10 million of EBITDA compared to Q1 of 2022. For adjusted diluted earnings per share, we’re anticipated a range of $0.26 to $0.33 per share. This framework assumes sequential Mobility EBIT improvement from the fourth quarter, given continued outpacing of global auto builds and margin recovery.

Typical seasonal refinish buying decline that is expected to result in lower sequential Performance Coatings EBIT despite a better industrial EBIT contribution from the fourth quarter and a stabilizing raw material environment, though pressure is anticipated to continue in specialty raws like non-TiO2 pigments, labor and energy costs. Altogether, we expect a first quarter low single-digit percent quarter-over-quarter of variable cost benefit, which translates into a high single-digit percent year-over-year headwinds. I will end with a few additional comments on our 2023 outlook. The macroeconomic situation remains difficult to forecast. However, we’re cautiously optimistic given our specific end-market mix and the progress towards post-COVID normalization that we’re expecting across most of our business portfolio.

We believe that the risks of further macro headwinds to Axalta is mostly contained within pockets of our industrial end markets, with Industrial already managing through a weaker global environment. Elsewhere, we have a resilient core centered around our Refinish business which has record profit once again in 2022, and we expect that trend to continue into 2023. Plus, we expect substantial Mobility Coatings upside from industry and margin recovery. In regards to cash flow, we will be focused on returning working capital towards our historical levels as a percentage of net sales. This represents a meaningful opportunity of cash into 2023. Our capital allocation framework will continue to be guided by our focus on deleveraging and balance sheet strength.

I expect the pace of share buybacks to remain somewhat muted beyond offsetting dilutions from share-based compensation as the new interest rate environment has increased the relative attractiveness of gross debt reduction. Net leverage is expected to improve meaningfully from the current levels as we grow earnings and deliver cash. We strongly believe in the earnings power of Axalta and the value-creation opportunity that lies ahead.

Chris Villavarayan: Thank you, Sean. I’d like to close out by thanking our global team. I had the opportunity to spend time with our team members in some of our manufacturing facilities. We have a talented group of operators who diligently help us serve our customers every day. I’m also grateful to our business and functional teams who are driving execution and accelerating Axalta’s growth plan. With that, we will be pleased to answer your questions. Operator, please open the lines for Q&A.

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Q&A Session

Operator: Thank you. And now we can go to the question-and-answer session. Our first question today is coming from Christopher Parkinson from Mizuho. Your line is now live.

Christopher Parkinson: Great, good morning. Chris, and understanding it’s incredibly early, but just given your background and your experiences, are there any — is there a preliminary thought process on what you can do to assist Axalta and better streamlining results in the Mobility segment, especially now that volumes and market share seem to be comfortably on the right track? Thank you.

Chris Villavarayan: Hey, good morning, Chris. Yes, absolutely. I think if you look at my background, a lot of it on the operations side. And as I think about Axalta in the short-term, it’s purely about execution. And this is where Rakesh started, as you could see in the last two quarters, and you can see the inflection from Q3 too Q4. And we certainly are going to continue to drive execution. So, as I think about operations, supply chain, procurement, what are we doing to drive continued cost improvements here, as well as the drive for continued pricing to ensure we continue to drive that price cost graph, that’s certainly the focus here, and that’s certainly from my background also at Meritor.

Christopher Parkinson: Understood. And just a quick follow-up, on the Refinish side, it seems you’ve been also winning a decent amount of share in terms of body shop, and consolidation among some of your largest customers and activities should also be a tailwind. When should we expect to see a lot of that through results in the Performance segment? Thank you.

Chris Villavarayan: Good question. So, I think as you know, Q1 Refinish is somewhat seasonal. So, as we see that continuing through the year, certainly in Q2, you should see the benefit from that. And again, if you think about the Refinish business, whether it’s ’21 to ’22, they’ve seen record growth. And as we think about ’23, certainly with the lens, again what we announced at — also at the Investor Day, what you can see is they’ve gained about 3,000 shops. The MSOs, as you pointed out, continue to consolidate, so certainly significant opportunity there going forward.

Christopher Parkinson: Thank you so much.

Chris Villavarayan: You’re welcome.

Operator: Thank you. The next question today is coming from John McNulty from BMO Capital Markets. Your line is now live.

John McNulty: Yes, thanks for taking my question. With regard to pricing, I guess can — can you help us to think about how ’23 looks if you didn’t raise price any further in any of the channels, just what would we be seeing for a full-year price increase in 2023? And then what channels — it does sound like there are certainly pockets where you feel you still are behind or have some inflationary pressures where you need further pricing. Can you fill in the blanks on that a little bit more and help us to understand the magnitude of — and where you might need to see those price increases?

Sean Lannon: Yes. Hey, John, it’s Sean. Good morning. So, as we think, I mean the last two quarters you’ve seen essentially 3% sequentially from Q2 to Q3, Q3 to Q4. So, we’re signaling low single digits next year, so call it $150 million of just pure pricing carryover. I think the dynamics just in a deflationary environment, it’s how quickly we deflate and how it ultimately impacts some of our raw material indexing. But with that said, even with Chris’ prepared remarks, the margin recovery is still not fully there. We expect to fully recover, from a total Axalta perspective, in the first-half of next year. But Mobility is still behind, as well as Industrial; Refinish has quickly caught up. But that’s really the focal areas, that being the two components within Mobility and Industrial.

John McNulty: Got it, fair enough. And then Chris, well, won’t ask you too much on the operational side, obviously you have a lot to dig into. But I guess high level, if when you think about the area of leverage for Axalta and also returning of cash to shareholders, I guess can you give us kind of how you think about those topics in general, what you think might be the right leverage levels for Axalta going forward? And also, is it something where you would consider pushing the Board to maybe think about dividends versus buybacks, do you have a preference there? Just if you can give us — just give us some of your early thoughts on how you think about that, that would be great?

Chris Villavarayan: Sure. I think initially, as Sean pointed out in his prepared remarks, our focus is on debt repayment. So, I think we’re going to continue to drive that. We’re at 3.8. Again, as you folks know, we were around 4. Our objective is to get that down around that 3 mark as we were before. And so that is going to be the primary focus for us going forward, especially with the current interest rate environment that’s certainly driving the focus towards debt repayment. In terms of, let’s call it, return to shareholders, it’s probably something we’ll look at later in the year. But right now, our absolute focus is on execution and debt repayment.

John McNulty: Got it, fair enough. And then maybe if you could just squeeze in one last one just around auto OEM. The volumes have been huge, and we were well aware of some of the big account wins that you had. Is there any initial fills — it’s not going to be like a big-box type thing, but are there any initial fills like where we should be thinking about that as we model out your performance relative to the broader global OEM market? Look, you’ve put out some huge numbers in the last couple of quarters. Is that an okay run rate, at least until that anniversaries or, again, was there maybe a little bit of a fill-in there that we need to consider?

Sean Lannon: Yes, I wouldn’t call it necessarily a fill. I would expect that we’re going to continue to outpace the market in 2023, maybe not exactly by the levels you saw in Q3 and Q4. Q4, in particular, we beat in every region. And it’s really a twofold reason, John. It’s the market wins, but more importantly, some of the OEMs and the platforms that we’re actually serving product to are actually outpacing the market. So, China is probably a really big bright spot. The market was down roughly 6% in the fourth quarter. We were well over 30%, and a big part of that is just the platforms that we’re actually serving are, quite frankly, just outpacing the market altogether.

John McNulty: Got it. Thanks very much for the color, appreciate it.